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Simply Wall St Company Analysis Model

Contents

Overview of the model

The Simply Wall Street (SWS) app is designed to help make you a better investor by allowing you to make non-emotional long term investment decisions.

The SWS app is not intended to provide investment advice or recommendations. Rather the SWS app is an analysis platform which provides information and analytics allowing investors to identify and assess stocks which meet their investment parameters and objectives - for example high quality consistent performers, income oriented stocks or growth oriented stocks. The results are presented in an easy to understand infographic form with the aim of making the underlying data more understandable to users.

To assess stocks, the SWS app performs a number of quantitative "checks" across a range of assessment criteria and provides the results in a visually intuitive Snowflake (see below).

The checks performed are based on widely accepted and tested investment criteria, and used by demonstrably successful investors and investment firms.

Our checks are divided into 5 assessment criteria:

Area Assessment Criteria
Value The fair value of the company's shares, and how that value compares with the current share price, other companies and the stockmarket
Future performance Anticipated future financial performance based on analyst forecasts
Past performance The historical financial performance of the company
Health The financial strength of the company's balance sheet
Dividends The dividend being paid, and the sustainability of the dividend

The assessment criteria and individual checks performed are explained in this document.

The Snowflake

The results of the checks in each of the 5 assessment criteria are presented visually in our Snowflake. The snowflake has been designed to present the results for a company as a visually intuitive summary in order to allow:

  • a quick "eyeball" scan of a particular stock, a group of stocks or the stockmarket as a whole;

  • visual comparisons of the results of our stock filters;

  • visual side by side comparisons of selected stocks using our "compare" feature;

  • consolidated view using our "portfolio" feature.

Example Snowflake

Example Snowflake Tile

Methodology behind generating the Snowflake

The snowflake is constructed as follows:

  1. for each assessment criteria, there are 6 individual checks performed (giving a total of 30 checks for each stock);

  2. if a check is successful, it is assigned a score of "1";

  3. the total successful checks are added to give an overall score for each assessment criteria - for example a stock may receive 4 successful check scores for "Health", giving a total Health score of 4 (from a possible 6);

  4. the total score for each of the assessment criteria is shown on the relevant axis of the snowflake.

The total scores for each assessment criteria are then used to generate the shape and colour of the snowflake. The greater the total number of successful checks the larger the snowflake.

In addition the snowflake is colour coded - the greater the number of successful checks the more "green" the snowflake - the fewer the more "red" the snowflake will appear.

Notes on shape and colour

While the size and colour of the snowflake broadly indicates the "quality" of the company, a low score in a particular assessment criteria should not necessarily exclude a stock from investment consideration. The snowflake simply summarises visually relevant characteristics of a stock.

For example, a low "Dividends" score simply indicates that from an Dividend point of view, the company may be paying a low dividend, however it may also be experiencing high growth and reinvesting cash in growth initiatives. In this example, investors seeking high growth opportunities may still consider the stock as an investment candidate.

Investors should therefore consider each of the assessment criteria in terms of their own investment objectives and orientation.

Changes in shape and colour/ Snowflake Sensitivities

The size and colour of a company snowflake will change over time as data is updated - in particular for updated earnings results and changes in share price.

The Snowflake is specifically designed to help investors become less emotional by ignoring minor share price fluctuations and focusing on the fundamentals. Four out of five axis only change when new company or analyst level data is available.

The sensitivity of the axis:

Area Main sensitivity
Value Sensitive to changes share price however the change must be significant to breach the various thresholds detailed in this document
Future performance Expected growth rates of earnings per share, revenue, cash flow and net income
Past performance Historical earnings per share performance
Health Balance sheet and ability to service debt
Dividends The reliability and sustainability of the dividend

Summary of the Snowflake

The graphic below summarises the checks used to generate the Snowflake. The remainder of this document explains each in detail and the analysis used in the Management screen.

A PDF of this graphic is available here.

Snowflake Summary

Value

While the stockmarket sets a "price" for a company, the stockmarket price will often be affected by a wide range of factors, many of which may not affect the true worth or fair value of a company. By comparing the stockmarket price to the fair value of a company, or other companies or indices, investors can determine whether a company's shares are potentially under or overvalued.

There are many methods which can be used to determine the fair value of a company. The SWS app uses a method known as Discounted Cash Flow (DCF).

Discounted Cash Flow (DCF)

DCF is the most widely accepted method to calculate the fair value of a company.

DCF is based on the premise that the fair value of a company is the total value of its free cash (FCF) (ie cash revenues less cash expenses), discounted to today's value.

A 2 stage model is used which includes 5 years of growth followed by perpetual stable growth.

The SWS DCF calculation can be performed for any listed stock, subject to available data and ideally analyst coverage. The analysis model is 100% quantitative (no human intervention) therefore conservative assumptions are used where possible and large margins are required to be flagged as potentially undervalued.

The SWS DCF calculation is performed as follows:

  1. Estimates of Levered Free cash flows are used for the short term "growth" period of 5 years. The source of this data is analyst consensus estimates. If no estimates are available the last estimated or reported value is extrapolated using a capped historical average annual growth rate. In the case of a financial institution dividends per share are used;

  2. Free cash flows beyond the short term period - the "stable" period - (known as Terminal Value) are estimated using the Perpetuity Method (Gordon Formula) which uses a long term growth rate (this assumes that the company continues to operate into perpetuity);

  3. The sum of the cashflows arising from the forecasts are "discounted" to today's value using a discount rate;

  4. The total value arrived at is divided by the number of shares on issue, giving a value per share.

Which cash flow is discounted?

As the calculation is intended to be used for valuing stocks, an Equity valuation is performed. In contrast a Firm valuation would include the value to any debtors and uses Levered Free Cash Flow.

How are financial institutions handled?

In the case of Banks, Financial Service companies, REIT’s and Insurance firms, dividends per share (DPS) are used, as Free Cash Flow is difficult to estimate and often not reported by analysts. Unless a company pays out the majority of its FCF as a dividend, this method will typically underestimate the value of the stock.

The Gordon growth model is used which assumes the dividends will grow into perpetuity at a rate that can be sustained. The inputs for this growth rate are the same for the stable period in the non-financial model.

Using the expected Dividend per share the value of the stock is found by:

Value = Expected dividends per share / (Discount Rate - Perpetual growth
rate) 

Read more on the difficulties of estimating free cash flow for financial institutions.

Advantages and Disadvantages of DCF

The advantages of DCF are:

  • The DCF value is not affected by emotional or unquantifiable factors (which often affect stockmarket prices);

  • DCF uses objective, measurable data and inputs to calculate a fair value;

  • DCF allows investors to determine whether the share price of a company is potentially under or overvalued.

The drawbacks of DCF are:

  • The DCF calculation is sensitive to its key inputs - the growth rate and the discount rate. Relatively small changes in these inputs affects the final value significantly;

  • DCF is a purely quantitative technique which does not take into account non-financial information;

  • DCF is not applicable to companies which does not generate positive free cash flow (for example high growth technology companies which are not profitable);

  • Estimating Free Cash Flow (FCF) for financial institutions can be difficult.

Determining the key inputs

The key inputs used in the DCF calculation are detailed below.

High growth period (5 year)

Consensus estimates (e.g. the mean of 20 analysts) for Levered Free Cash Flow or Dividends are used. If this does not exist for any given year the cash flow is assumed to grow at the average annual growth rate in revenue from the last 5 years. If the extrapolated growth rate is used this is capped at 20% in the first year declining by 1% per year.

Stable growth period (Terminal Value)

The Perpetuity Method (Gordon Formula) is used to calculate Terminal Value at an annual growth rate equal to the 10 year government bond rate.

Determining the Discount Rate

The Discount Rate is the rate used to "discount" future cashflows into today's equivalent values. The Discount rate takes into account current interest rates, inflation and also a risk premium (due to uncertainty or the risk characteristics of a stock).

What discount rate is used?

In the case of a Free Cash Flow to Equity Calculation the Cost of Equity is used as a discount rate. This is calculated from the Risk Free Rate (the 10 year government bond rate is used), the stocks Beta (see below) and a Market Risk Premium (Currently 10% - Risk Free Rate).

How is the bottom up Beta calculated?

A stocks 'Beta' is measure of the volatility, or risk, in comparison to the market as a whole. A bottom up Beta is calculated for each company by looking at the Unlevered Beta (excluding debts) for companies in the same industry and then levered to account for any debt. The bottom up Beta cannot be lower than 0.8 (lowest practical Beta for stable firm - per Damodaran).

The Levered is used in the case of financial firms, but it is not adjusted for financial leverage like with non-finance firms. Therefore the average levered beta from comparable firms is used as the bottom-up beta.

Example calculation

Below is an example calculation for Walt Disney (NYSE:DIS) from 22/09/2015. Note the details of the calculation can be found for any stock on SWS by clicking ‘Learn more’ or by clicking the infographic.

**5 year cash flow forecast**
                                2015            2016            2017            2018            2019
Levered FCF (USD, Millions)     $6,563          $8,491          $9,704          $11,063         $12,434
Source                          Analyst x16     Analyst x16     Analyst x10     Analyst x8      Analyst x5
Present Value
Discounted (@ 8.4%)             $6,053          $7,223          $7,613          $8,006          $8,299

Present value of next 5 years cash flows:
$37,195

**Terminal Value**
Terminal Value = FCF2019 × (1 + g) ÷ (Discount Rate – g)
Terminal Value = $12,434 × (1 + 2.1%) ÷ (8.42% – 2.1%)
Terminal value based on the Perpetuity Method where growth (g) = 2.1%:
$201,152
Present value of terminal value:
$134,257

**Equity Value**
Equity Value (Total value) = Present value of next 5 years cash flows + terminal value
Value = Total value / Shares Outstanding ($171,452 / 1,688)
Value per share: 
$101.58

----------------------------------------------
Current discount (share price of $103.41): -2%
----------------------------------------------


**Estimate of Discount Rate**
The discount rate, or required rate of return, is estimated by calculating the Cost of Equity.
Discount rate = Cost of Equity = Risk Free Rate + (Levered Beta * Equity Risk Premium)
Discount rate = 8.42% = 2.11% + (0.8 * 7.89%)


**Estimate of Bottom Up Beta**
The Levered Beta is the Unlevered Beta adjusted for financial leverage. It is limited to 0.8 (lowest range for a stable firm).
Levered Beta = Unlevered beta (1 + (1- tax rate) (Debt/Equity))
0.569 = 0.536 (1 + (1- 30%) (8.75%))
Levered Beta used in calculation = 0.8
Data point Notes
Levered Free Cash Flow estimates +1 to +5 years Annual
Levered Free Cash Flow actual last reported Annual
Revenue (LTM to -5 years) Annual
Debt to equity ratio Annual, last reported
Dividend per share Annual, last reported
Return on equity (ROE) Last reported

Recommended reading for those wishing to learn more on DCF

The SWS Snowflake checks regarding value

The SWS performs 6 checks regarding "value".

Discount to Intrinsic Value (DCF)

CHECK #1: Is the discounted cash flow value less than 20% of the share price?

The SWS app compares the fair value (ie the calculated DCF value) to the current share price.

If the share price is => 20% below the fair value, it is considered to be moderately undervalued and is scored one point.

CHECK #2: Is the discounted cash flow value less than 40% of the share price?

The SWS app compares the fair value (ie the calculated DCF value) to the current share price.

If the share price is => 40% below the fair value, it is considered to be substantially undervalued and is scored one point.

PE Ratio

The Price to Earnings (PE) ratio is used to give an indication of the value of the share price as a function of the company's earnings (ie net profit per share).

The PE ratio is a market based ratio which provides a short hand indication of the relative valuation of a company. This allows a comparison of the valuation between companies, against an industry sector or the stockmarket as a whole.

The higher the PE ratio, the more "expensive" the stock is considered to be. For example, a company with a PE ratio of 25 times would be considered more "expensive" than a company with a PE ratio of 15 times, or the whole market average PE of 18.

The Price to Earnings Ratio is calculated as:

PE ratio = Current share price / Earnings per share

There are many different ways to calculate the PE ratio. SWS uses the following data points:

Data point Notes
GAAP Earnings per Share (Annual, last reported),converted to the currency of the listing if different.
Share price End of day in the currency of the listing
CHECK #3: Is the PE ratio less than the market average but still greater than 0?

The PE ratio is compared to the whole market PE ratio for the country of listing.

If the PE ratio is less than the market average PE the stock is scored one point.

CHECK #4: Is the PE ratio less than the industry average but still greater than 0?

The PE ratio is compared to the industry average PE ratio for its industry classification.

If the PE ratio is less than the industry average PE the stock is scored one point.

PEG Ratio

The Price to Earnings Growth (PEG) ratio is used to give an indication of the value of the share price as a function of the growth in a company's earnings (ie rate of growth of net profit per share).

The PEG ratio is a market based ratio which provides an indication of the relative valuation of a company taking into account the rate of growth in the company's earnings. This allows a comparison of the valuation between companies, against an industry sector or the stockmarket as a whole.

The higher the PEG ratio, the more "expensive" the stock is considered to be taking account the company's rate of earnings growth. For example, a company with a PEG ratio of 1.2 would be considered more "expensive" than a company with a PEG ratio of 1.0. Stocks are considered to have a "fair" PEG ratio of between 0.8 and 1.0.

The PEG ratio is not usually compared to a market average due to the diversity and differing nature of companies across the market.

The Price to Earnings Growth (PEG) Ratio is calculated as;

PEG ratio = PE ratio / Expected earnings growth next year (%)

The PEG ratio depends greatly on the PE ratio and growth rate used, SWS uses:

Data point Notes
PE Ratio As above
Expected annual growth rate in EPS next year Based on consensus analysts’ estimates next year (same as the 1 year EPS growth rate used in Future Performance analysis

Note: Other websites may quote different PEG ratios, this is due to using out of date EPS growth rates or using a growth rate based on historical data.

CHECK #5: Is the PEG ratio within a reasonable range (0 to 1)?

The PEG ratio is compared to the range of 0 to 1.

If the PEG ratio falls within this range the stock is scored one point.

PB Ratio

The Price to Book (PB) ratio is used to give an indication of the value of the share price as a function of the "book value" of a company. The book value is calculated as assets less intangible assets less liabilities per share - in the other words the net tangible assets held by the company.

The PB ratio allows a comparison of the valuation between companies, against an industry sector or the stockmarket as a whole.

The higher the PB ratio, the more "expensive" the stock is considered based on the company's net tangible assets. For example, a company with a PB ratio of 4.0 would be considered more "expensive" than a company with a PB ratio of 3.0.

The PB ratio is most commonly compared to the relevant industry average as companies within an industry average will usually have common asset characteristics - for example airlines are capital intensive businesses usually with high asset holdings.

The Price to Book (PB) Ratio is calculated as;

PB ratio = Stock Price / Book Value per Share

SWS uses the following data points to calculate PB ratio:

Data point Notes
Book value per share Annual, last reported
Share price End of day in the currency of the listing
CHECK #6: Is the PB ratio within a reasonable range (0 to 1)?

The PB ratio is compared to the relevant industry average.

If the PB ratio is >0 but below the industry average the stock is scored one point.

Future Performance

The SWS app does not attempt to predict future share prices. Rather the SWS app assesses future expectations of company performance by analysing professional analyst estimates of Revenue, Cash flow, Earnings (Net income) and Return on Equity. SWS looks for growth in these metrics. Historically it has been demonstrated that analyst estimates on average are accurate within an acceptable range.

The SWS Snowflake checks regarding Future Performance

Minimum Earnings Growth

SWS undertakes two checks on estimated growth in Earnings per Share (EPS) over the next 1 and 3 years to determine whether it is expected to exceed minimum acceptable growth. The minimum acceptable growth is defined as the low risk savings rate plus a premium to keep pace with inflation. If these checks are not met it may be more rational to invest in a low risk savings product rather than the stock being reviewed (which carries a higher level of risk).

How is growth from negative earnings handled?

Calculating a growth rate when the earnings in the starting period are negative is difficult and sometimes meaningless, for this reason no ‘growth’ ratio is used rather SWS informs the user this is the case and awards scores accordingly.

Data used to perform this check:

Data point Notes
Historical GAAP Earnings per Share (LTM to -5 years) Annual period but quarterly results are presented in the infographic
Estimated GAAP Earnings per Share (+1 to +3 years) Annual based on consensus analyst estimates
Growth rate % This is interpolated if the last reported quarter differs from the quarter of consensus estimates
Low risk savings rate Based on the readily available consumer savings account interest rate, varies depending on the region of the listing
Inflation (CPI) The CPI of the region of the listing is used
CHECK #1: Is the growth in earnings expected to exceed the low risk savings rate, plus a premium to keep pace with inflation, in 1 year's time?

This check measures whether the earnings growth of a stock at least matches the low risk savings rate plus a premium to keep pace with inflation. If not, it may be more rational to invest in a low risk savings product rather than the stock being reviewed (which carries a higher level of risk).

The rate of growth in earnings (measured by the average analyst estimate) over one year is compared to the low risk savings rate + inflation over one year.

If the rate of growth of earnings is > the low risk savings rate the stock is scored one point.

CHECK #2: Is the growth in earnings expected to exceed the low risk savings rate, plus a premium to keep pace with inflation, in 3 year's time?

This check measures whether the earnings growth of a stock at least matches the low risk savings rate over the medium term. This check measures earnings growth over 3 years (rather than one) and may be used to identify companies where, although short term growth may be low (possibly due to temporary or one off factors), growth over the medium term is acceptable.

The rate of growth in earnings (measured by the average analyst estimate) over 3 years is compared to the low risk savings rate + inflation over 3 years.

If the rate of growth of earnings is > the low risk savings rate the stock is scored one point.

High growth potential

The final 3 checks undertaken here look to identify companies with the potential for high growth over the next 2 years.

Data used to perform this check:

Data point Notes
Estimated Revenue (+1 to +3 years) Annual based on consensus analyst estimates
Estimated Cash flow (+1 to +3 years) Annual based on consensus analyst estimates
Estimated Net Income (+1 to +3 years) Annual based on consensus analyst estimates
Current Revenue Annual, Last reported
Current Cash flow Annual, Last reported
Current Net income Annual, Last reported
CHECK #3: Does the average analyst expect Revenue to increase by 50% or more in 2 years?

This check is used to identify whether on average analysts' expect strong revenue (ie "top line") growth over the short / medium term of 2 years.

Growth in top line Revenues is an indicator of whether a company is increasing its gross sales, which may be due to increasing prices, market share or sales from new products or services.

If the average analyst estimate of revenue is > 50% in 2 years time the stock is scored one point.

CHECK #4: Does the average analyst expect Operating Cash Flow to increase by 50% or more in 2 years?

This check is used to identify whether on average analysts' expect strong cashflow growth over the short / medium term of 2 years.

Growth in Operating Cash Flows indicates whether the company is growing free cash from its "operational" activities. In some circumstances free Cash Flow is a better measure of a company's performance than profit, as the profit figure may be distorted by transactions and adjustments which are not related to the company's day to day operations.

Cash from "investing" activities is excluded from this check as these activities are largely unrelated to the normal operations of a company (eg from capital or debt raising activities).

If the average analyst estimate of Operating Cash Flow is > 50% in 2 years time the stock is scored one point.

CHECK #5: Does the average analyst expect Net Income (Profit) to increase by 50% or more in 2 years?

This check is used to identify whether on average analysts' expect strong Net Profit (ie "bottom line") growth over the short / medium term of 2 years.

Growth in Net Income indicates whether the company is growing profitably. Fundamentally a company's value will increase as a result of increasing Net Profit over the medium / long term.

If the average analyst estimate of Net Income (Profit) is > 50% in 2 years time the stock is scored one point.

Return on Equity (ROE)

Return on Equity (or Return on Shareholders Funds) measures profitability in terms of a company's shareholders funds, so provides an indication of the profitability and efficiency of the usage of the company's own funds to generate profits.

Return on Equity is calculated as:

Return on Equity = Net Income / Average Equity (Shareholders Funds)
Data point Notes
Current Return on Equity Last reported
Estimated Return on Equity in 3 years Based on consensus analyst estimates

The main advantage of ROE is that it takes into account movements in equity issued by the company which may distort other measures of profitability. The main disadvantage is that ROE is not affected by the level of debt (or additional debt) held by a company.

The higher the ROE, the higher the return generated by the company, and vice versa.

An ROE of 20% or greater is considered to be indicative of a company which is highly profitable / efficient.

CHECK #6: Is the Return on Equity (ROE) in 3 years expected to be over 20%?

The Return on Equity (ROE) in 3 years' time is calculated based on the average analyst estimates of earnings.

If the ROE in 3 years’ time is estimated to be > 20% the stock is scored one point.

Past Performance

The Past Performance section of the SWS app provides an analysis of a company's historical performance over the past 5 financial years.

The SWS Snowflake checks regarding Past Performance

Historical Earnings per Share (EPS) growth

Earnings per Share (EPS) measures company earnings expressed on a per share basis.

EPS is calculated as:

EPS = Net Profit / Average number of shares on issue during the year

The EPS figure is widely used to measure the absolute profit that a company earns on a per share basis. As it uses a common base, EPS can be used to compare different companies and industries. For that reason it is used in the calculation of the Price to Earnings (PE) Ratio, which gives an indication of the relative price of different companies' stock prices.

An important advantage of EPS is that distortions which may arise from changes in the number of company shares issued (eg arising from an equity capital raising) are accounted for. An important disadvantage of EPS is that it does not consider the shareholder's funds employed or the level of debt held by a company.

Data points used in the Earnings per Share checks:

Data point Notes
Historical GAAP Earnings per Share (LTM to -5 years) Annual, last reported quarterly results

How is the 5 year annual average calculated?

To calculate the 5 year annual average growth a linear regression trend line is fitted to the historical quarterly LTM EPS data and the gradient (M coefficient) divided by the average earnings over the same period. This not only produces the best overall growth trend but also handles some negative earnings.

How is growth from negative earnings handled?

Calculating a growth rate when the earnings in the starting period are negative is difficult and sometimes meaningless, for this reason no ‘growth’ ratio is used rather SWS informs the user this is the case and awards scores accordingly.

CHECK #1: Is Has Earnings Per Share (EPS) growth exceeded that of the company's industry average over the past year?

If the EPS growth of the company is > the EPS growth of its relevant industry average the stock is scored one point.

This check measures the performance of the company against its peer group average.

CHECK #2: Is Have Earnings Per Share (EPS) increased in past 5 years?

If the EPS for the current year is > the EPS from 5 years ago the stock is scored one point.

CHECK #3: Is the current EPS growth higher than the average annual growth over the past 5 years?

If current year growth in EPS is > the average annual growth in EPS over the past 5 years the stock is scored one point.

Return on Equity (ROE)

See earlier section for full detail on Return on Equity.

Data point Notes
Current Return on Equity Last reported
CHECK #4: Is the Return on Equity (ROE) higher than 20%?

If the ROE for the company for the current year is > 20% the stock is scored one point.

Return on Capital Employed (ROCE)

Return on Capital Employed (ROCE) measures the profitability of a company in terms of the total capital employed by the company, both equity (or shareholders funds) and long term liabilities (which are often primarily made up of debt).

ROCE is calculated as:

Return on Capital Employed (ROCE) = Net Income / Long Term Liabilities

ROCE measures the efficiency of the usage of the company's total available capital, and is often used in conjunction with ROE to provide a more comprehensive measure of profitability. In particular ROCE takes into account debt (and increased debt) utilised by a company to generate returns.

The higher the ROCE, the higher the profitability of the company, and vice versa.

Data point Notes
Net income (LTM & -3 years) Annual
Long term liabilities (LTM & -3 years) Annual
CHECK #5: Has the Return on Capital Employed (ROCE) increased from 3 years ago?

If the current year ROCE is > the ROCE from 3 years ago the stock is scored one point.

Return on Assets (ROA)

Return on Assets (ROA) calculates the profitability of a company in terms of the total Assets held by the company. It is a broad measure of the efficiency of asset usage by the company and is often used to compare the returns of companies in capital intensive industries such as manufacturing or raw materials production.

ROA is calculated as;

Return on Assets (ROA) = Net Income /Total Assets
Data point Notes
Current Return on Assets Last reported
CHECK #6: Is the Return on Assets (ROA) above industry average?

If the current year ROA is > the relevant industry average the stock is scored one point.

Health

The Health section of the SWS app provides an analysis of a company's financial position, primarily in terms of the company's Balance Sheet, and in particular the amount of debt held by the company.

Point to note regarding Health metrics

Financial Institutions (Banks, Financial Service companies, REIT’s and Insurance firms) by their nature borrow the majority of their funding (or liabilities), and as a result conventional measures of debt levels are not generally applicable. For that reason the SWS app uses a separate series of Health checks specifically applicable to Financial Institutions.

Non-financial institutions analysis

The analysis performed for non-financial institutions uses the following data points as input:

Data point Notes
Short term Assets Last reported
Long term Assets Last reported
Short term liabilities Last reported
Long term liabilities Last reported
Total debt (LTM to -5 years) Last reported
Total shareholders equity (LTM to -5 years) Last reported
Operating cash flow Annual, last reported
Net interest expense Annual, last reported
Net income Annual, last reported

Full balance sheet data is visualized in the infographic.

Balance sheet checks

CHECK #1: Are short term assets greater than short term liabilities?

This check measures whether, on a short term basis (< 12 months), the company has a net positive financial position. In the event of financial stress, this check indicates whether the company could liquidate short term assets to meet its short term liabilities.

If the company's short term assets are > short term liabilities the stock is scored one point.

CHECK #2: Are short term assets greater than long term liabilities?

This check measures whether the company holds short term assets which are greater than its long term (>12 months) liabilities. In the event of financial stress, this check indicates whether the company could realise short term assets to meet its long term liabilities.

If the company's short term assets are > long term liabilities the stock is scored one point.

Debt to Equity Ratio

The Debt to Equity ratio measures a company's total debt relative to its total shareholders equity (ie net worth or shareholders funds). This ratio measures the amount of gearing or leverage that a company holds. If the ratio is high, this indicates that the company is holding a high level of debt / liabilities compared to its net worth, and in the event of financial stress may experience difficulty meeting debt or interest obligations.

A ratio of 40% or less is considered acceptable.

The Debt to Equity ratio is calculated as;

Debt to Equity ratio = Total Liabilities / Shareholders Equity
CHECK #3: Has the debt to equity ratio increased in the past 5 years?

The Debt to Equity ratio for the current year is compared to the debt to equity ratio 5 years ago. If the ratio has not increased, or has fallen, the stock is scored one point.

CHECK #4: Is the debt to equity ratio over 40%?

If Debt to Equity ratio is < 40% the stock is scored one point.

CHECK #5: Is debt covered by short term assets?

This check indicates whether, in the event of financial stress, the company is able to meet its debt obligations by realising short term assets.

Debt held the company is compared to Total Short Term Assets. If Total Short Term Assets are > Total Debt the stock is scored one point.

CHECK #6: Are earnings greater than 5x the interest on debt (if company pays interest at all)?

This check indicates whether the company's interest obligations are met through earnings (net income). A ratio of 5 times earnings indicates a strong level of coverage.

If Net Income is > 5 x interest on debt the stock is scored one point.

Financial Institutions

This analysis is used in the case of Banks, Financial Service companies, REIT’s and Insurance firms.

The following data points are used in addition to the previous for this analysis:

Data point Notes
Total deposits Last reported
Total loans Last reported
Total non-performing loans Last reported
Allowance for non-performing loans Last reported
General/ Specific allowance Last reported (Represents reserves created for problem loans)
Net charge offs Last reported
CHECK #1: Is Leverage (Assets to Equity) > 20x?

Leverage (or gearing) refers to the amount of assets held in a business when compared to the company's own resources (shareholders funds or equity).

While Financial Institutions will always have an elevated level of leverage, if the level becomes too high the institution may come under stress in the event of adverse circumstances. A leverage ratio of 20 times or less is considered acceptable.

Total Assets are compared to Shareholders Equity. If Total Assets are < 20 times Shareholders Equity the stock is scored one point.

CHECK #2: Coverage of bad loans (Bad Loan Coverage) > 100%?

Bad loans are loans made by Financial Institutions which are considered to be unrecoverable. Bad loan coverage refers to provisions set aside against potential bad loans. A provision of this nature is offset against profits.

Bad loan provisions held are compared to the level of Bad loans actually written off. If the Bad Loan provisions are > actual Bad Debts written off the stock is scored one point.

CHECK #3: Proportion of lower risk deposits compared to total funding (Deposits to Liabilities) < 50%?

Financial Institutions borrow money (to lend) in many different forms. Deposits from customers generally bear the lowest risk as they are less volatile than other forms of borrowing in terms of both the amount available (which does not usually change quickly) and interest rate paid (the rates paid are set by the Financial Institution itself).

Broadly the higher the level of Deposits held the less risky the Financial Institution is considered to be.

Total Deposits held are compared to Total Liabilities. If Total Deposits are > 50% of Total Liabilities the stock is scored one point.

CHECK #4: Proportion of higher risk assets compared to total assets (Loans to Assets > 110%)?

The Loans to Assets ratio measures the net loans outstanding as a percentage of total assets. The higher this ratio indicates a bank has a high level of loans and therefore its liquidity is low. The higher the ratio, the more risky a bank may be to higher defaults.

Financial firms such as Banks with high Loans to Assets ratios rely on interest income from loans and other securities for a high portion of their total revenue. Those with lower ratios have more diversified sources of revenue, for example from investment banking and asset management.

If Net Loans are < 110% of Total Assets the stock is scored one point.

CHECK #5: Total loans compared to deposit funding (Loans to Deposits > 125%)?

The Loans to Deposits (LTD) ratio measures the liquidity of a Financial Institution. Liquidity refers to the funds available to a Financial Institution to repay liabilities, in particular Deposits (recognising that Deposits must generally be repaid on demand, or at short notice). Loan assets on the other hand generally have a fixed term, and often cannot be readily realised.

If the LTD ratio is too high, the Financial Institution may experience difficulty repaying Deposits if unusual circumstances arise. The observed LTD range is 50% (very liquid) to 175% (illiquid).

Total Loans held are compared to Deposits held. If Total Loans are < 125% of Deposits held the stock is scored one point.

CHECK #6: Level of bad loans (Net Charge Off Ratio > 3%)?

The level of Bad Loans incurred by a Financial Institution is a key indicator of the quality of loans made. A high level of Bad Loans may indicate that the Financial Institution is engaged in overly risky lending practices.

If Bad Loans written off is < 3% of Total Loans held the stock is scored one point.

Income (Dividends)

The Income section of the SWS app provides an analysis of a company's dividend (income) payments to its shareholders.

The app analyses the dividend payment in terms of its absolute level and against other dividend payers. In addition the app analyses the volatility and sustainability of the dividend.

Note that if a company pays a dividend of less than 0.5%, or no dividend, no further Income checks are undertaken.

Dividend Yield %

The Dividend Yield % is the annualised dividend paid expressed as a function of the company's share price:

Dividend Yield = Annualised Dividend paid ($) / Share Price

Note that the Dividend Yield % will change as the share price changes.

Data points used to in the Income analysis:

Data point Notes
Dividend yield (End of day to -10 years) Annual
Dividend per share (LTM to -10 years) Annual, last reported
Payout ratio Last reported
Estimate of Dividend per Share (+3 years) Annual, from analyst consensus estimates
Estimate of GAAP Earnings per Share (+3 years) Annual, from analyst consensus estimates

Note: For an American Depository Receipt (ADR) or equivalent the dividend yeild is derived from the the primary listing of the stock, not the ADR.

CHECK #1: Is the current dividend yield higher than the cash savings rate?

If the Dividend Yield is > the cash savings rate (for the relevant geography) the stock is scored one point.

CHECK #2: Is the current dividend yield in the top 25% of dividend paying stocks?

If the Dividend Yield is within the top 25% of dividend paying stocks (for the relevant geography) the stock is scored one point.

CHECK #3: Has the dividend been volatile in the past 10 years?

To check for volatility SWS looks at the historical dividend per share payments, if at any point in the last 10 years a drop of greater than 10% has occurred the dividend is considered volatile. Note this check is based on the per share dividend amounts paid, not the yield.

One point is scored if there have been no annual drops in DPS of more than 10% in the past 10 years. This check also fails by default if the stock has been paying a dividend for less than 10 years.

CHECK #4: Has the dividend increased in the past 10 years?

The current annualised dividend amount paid is compared to the annualised dividend amount paid 10 years ago. This check also fails by default if the stock has been paying a dividend for less than 10 years.

If the current annualised dividend amount is > the annual dividend amount 10 years ago the stock is scored one point.

CHECK #5: Are dividends paid well covered by Net Profit (or Net Income)?

The payout ratio (as defined below) is used to check if the dividend is affordable by the company.

Payout ratio = Dividends per share / Earnings per share

If the payout ratio is greater than 0% and less than 90% the stock is scored one point.

CHECK #6: Are future expected dividends paid well covered by Net Profit (or Net Income)?

To check for future dividend coverage the payout ratio in 3 years’ time is estimated. This is done using consensus analyst estimates for Dividend per share payments and Earnings per share.

If the estimated payout ratio in 3 years is greater than 0% and less than 90% the stock is scored one point.

Management

Metrics related to company management are not incorporated in the Snowflake, however are included within the app as additional information to assist with investment decision making.

The Management checks are designed to highlight whether CEO compensation is reasonable and consistent with company performance. If CEO compensation is out of step with company performance or the marketplace, this may indicate that management's interests are not well aligned with the company or shareholders.

In addition we provide an analysis of management tenure as an indicator of stability and alignment with the company and shareholders. If management or Board tenure is relatively short, this may indicate instability or uncertainty within the company.

We finally analyse recent (up to 12 months) "insider" (ie The Board and Management) share purchases and sales in the company. If company insiders are net sellers of shares this may indicate a lack of confidence in the future prospects for the company.

The following data is used in the SWS management analysis:

Data point Notes
Historical CEO total compensation (LTM to -5 years) Annual, last reported
GAAP Earnings per Share (LTM to -5 years) Annual, last reported
Management team average tenure Calculated by averaging the tenure of the top 10 ranked ‘Professionals’
Board of directors average tenure Calculated by averaging the tenure of the top 10 ranked Board of directors
Number of shares sold by insiders Last reported, includes options exercised
Number of shares bought by insiders Last reported, includes options exercised
CHECK #1: Is the CEO's compensation unreasonable compared to market cap and earnings?

Whilst extensive analysis on CEO compensation exists there is no industry standard metric or ratio to check for unreasonable levels compared to company performance. We based our check on an excellent article from Fool.com in 2014.

(From the Fool.com)

In 2013, the average S&P 500 CEO earned $10.5 million, a new record. Total profits of S&P 500 companies were about $1 trillion, or $2 billion on average, meaning the average CEO's compensation was about 0.5% of the company's profit, or 0.03% of market cap, which is about $35 billion on average. Since executive pay seems like it should be tied to company profits and market value, perhaps we should use that as a starting point.

Therefore this check is flagged if the following occurs:

CEO Comp > (0.5% * Net Income + 0.03% * Market Cap)
CHECK #2: Has the CEO's compensation increased more than 20% whilst the EPS is down more than 20%?

The increase in CEO compensation over the most recent financial period is compared to the movement in company earnings per share (EPS) over the most recent financial period.

If CEO compensation has increased more than 20%, and the company's EPS has fallen more than 20%, this check is flagged.

CHECK #3: Is the average tenure of the management team less than 2 years?

If the average tenure of the management team on average is < 2 years this check is flagged.

CHECK #4: Is the average tenure of the Board of Directors team less than 3 years?

If the average tenure of the Board of Directors is < 3 years this check is flagged.

CHECK #5: Are company "insiders" net buyers or sellers of the company's shares?

If company "insider" share sales is greater than the number of share purchases this check is flagged. Insider trading activity is defined as a transaction from an internal stakeholder with an interest in the companies’ stock performance. Insiders can be individuals or corporates.

What transactions are included in this check?

The following transactions are included in the Insider Trading check:

  • Open Market Acquisition (Buy)
  • Open Market Disposition (Sell)

Equivalent to transaction type P/S on an SEC Form 4 filing.

Industry Averages

Industry averages are calculated by region on a weekly basis. The calculation for each data point is weighted by market cap.

Currency

Any currency conversions are undertaken using end of day conversion rates.